There is an old stock market maxim that says we should “sell in May and go away.” Like most proverbs or cliches, it has a foundation in truth. From the 1950s to 2013, the Dow Jones Industrial Average saw lower returns between May and October before picking up around November to April.
However, since 2013, this once-reliable seasonal pattern has become less predictable. Indeed, the composition of indexes seems to be at play here. The S&P 500 is heavily weighted with tech stocks, so exiting the market in recent years would have meant lost gains in growth stocks.
Another factor to consider is that this May is a somewhat unique scenario. The COVID-19 pandemic crash, followed by the government stimulus-response, has led to extraordinary levels of growth. Timing the market is never easy, so investors risk missing out on returns.
Investors should know that stock returns do slow down in the summer months in British and European markets. However, there are a few caveats to this approach that investors should consider.
- Nominal interest rates are currently lower than inflation. Additionally, real rates are negative. So, even if market returns are lower during this six-month period, exiting into cash is a losing proposition.
- Moving out of stocks generates taxes. If the plan is to dip out for the summer, then by the time they come back in November, investors should make sure their calculations are correct.
Of course, some believe getting out this May could be a good strategy this year. Carter Worth, at Cornerstone Macro, suggests that stocks are toppy at the moment and believes there is some wisdom in exiting the market on this basis alone. Worth does go on to say that he considers a seasonal approach a poor choice and that leaving money exposed to the market is a better move.
Mark Yusko at Morgan Creek Capital Management suggests gains in commodities could lead to inflation in Q2. Additionally, he believes capital gains taxes and higher interest rates could lead to a rotation out of growth stocks and into value names.
While all of this is interesting, we can’t escape that we’re still in a bull market. While historically selling in May may have been wise, selling this May could mean missing out on significant returns. Failing to time the top and also facing a tax bill would be a double-blow.
While the US and UK have rolled out successful vaccine programs, globally, the COVID crisis is far from over. There is still some room for disruption.
However, as Ryan DetrickLPL at LPL Financial notes, the data suggest that over the last ten years, a strong April usually means a solid next six months. For example, April gains of 5% in the S&P 500 have been followed by 6.2% gains from May through October.
With many companies posting high earnings, the market is bullish. Exiting the market carries a penalty of a tax bill, so the best thing for investors this year is to stay put, so they don’t miss out on gains.
Stock market analysts are worried. US stocks are at an all-time high, with many declaring that we are witnessing a bubble. Investing in an expensive market poses an interesting dilemma. If the bubble bursts, losses will be sharp and dramatic. On the other hand, prices are rising, and gains are there for the taking.
In a recent note, JP Morgan addressed this very problem. Their research into expensive markets provided some interesting analysis, namely that 80% of markets that crash severely eventually come back to all-time highs.
The note suggested that while the dot-com boom eventually became delivered, specific markets like Japanese Nikkei have never recovered from their late 80s peak. As a result, they suggest that investors should buy, rather than avoid, bubbles.
When too many people passively invest, it can increase the prices of an already expensive market. Overbought index funds increase the cost of underlying stocks, decreasing market efficiency and allocating capital to the undeserving stocks. Within index funds, well-performing stocks can drag the underperformers along with their momentum, resulting in overvalued shares.
In the 12 years since the financial crisis, the US stock market has grown massively. The MSCI USA Index is up 641 per cent since March 9, 2009. By way of comparison, the MSCI World (excluding USA) index increased by 246 per cent in the same timeframe. This pattern has continued since the pandemic.
By many metrics, such as the cyclically adjusted price-to-earnings, US stocks are overvalued. Much of the recent surge can be attributed to the economic stimulus from the US government and the Federal Reserve.
With many passive funds overexposed to stock that has grown with little relation to its earnings, the merits of active investment are clear.
Timing the market is tough. According to Duncan Lamont, Schroders’ head of risk and analytics, shifting out of stocks is a losing strategy. He notes that an aversion to high-priced stocks would have kept most investors out of the market over the last decade.
All of this has left many investors confused about how to proceed. The market is expensive and may yet crash, and with indexes seemingly overbought, the art of stock picking will return.
The inverse relationship with stock returns and earnings has traditionally spelt trouble in the past. Indeed, Warren Buffett warned that younger investors are in the process of learning some “very expensive lessons.”
For me, it’s about stock picking – good old-fashioned bottom up, value, growth, income, dividends, cashflow, volatility, alpha.
Alpesh Patel OBE
What are your plans this year? Sell in May or stick it out over summer? Let us know in the comments section below.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.